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    Predetermined overhead

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    1. Calculate the predetermined overhead rate for 2013 and the amount of over/under applied overhead applicable to January. Overhead is applied based on direct labor costs. Assume that the actual overhead incurred in the month is $705,000.

    The Fabulous Widget Company has been producing a single product, called the computer widget, since 1995. A black generic widget, which was the company's original product, is produced for general consumption and is sold through major computer stores. In 2010, a new line of brightly colored computer widgets (red, purple and green) was introduced. Widgets produced for this market are designed to meet specific requirements of the buyer.

    The black widget is produced evenly (1,400,000 units) throughout the year with approximately 116,500 units produced each month in a single production run. To maintain quality, at the end of each month, the system is stopped, any required maintenance is performed and a new run is set up for the next month. The specialty widgets are produced on demand in runs ranging from 5,000 to 100,000 units. At the start of each specialty widget production run, the production system is modified to meet specifications and maintenance is performed. The company uses a job order costing system to account for manufacturing costs for both product lines.

    The black widget is a solid seller but there has been no increase in sales over the last three years. On the other hand, the specialty widget is a very popular product. Since its introduction, production volume has almost double each year. For the next year, company management expects demand to slow slightly but they still expect an annual increase of 20%.

    The selling price for both the black widgets and the specialty widgets has been set at $13.00 per unit. The company believes that the markup is appropriate for both products. The $13 selling price for the black widget was believed to be most that the market will bear given the competition. Competitors currently produce a similar product. In the past few months, the competitors' selling price has been dropped to $12 per unit. The lower selling price of the competitors is expected to have an impact on FWC sales of the black widget within 6 months. The specialty widgets might support a higher price given the dramatic increase in demand but the company is unwilling to increase the price since it fears new competition if the unit margin is higher. No competition exists in the specialty market as of yet but the CEO does not expect this to last indefinitely.

    The following information is provided on the production over the past two years as well as the unit costs. The decline in unit costs is due solely to an economy of scale as the fixed costs are applied over more units. Sales information for the past two years is also presented in the second schedule. The company is pleased to see the turnaround in profits. The introduction of the specialty widgets in 2010 apparently caused the company to initially experience a slid in earnings but over the past two years, the company has shown a significant increase in earnings and the profit percentage.

    Production process: One department, forming /assembling, is used to produce the widgets. Materials costs are added at the beginning of the process and direct labor costs are added to each job during the month as these costs are incurred. Overhead is applied as each job is completed and moved to finished goods. If jobs are incomplete at the end of the month, overhead is also applied to the incomplete jobs based on the amount of direct labor costs that have been attached to that job. As the incomplete job is finished during the next month, additional overhead is applied in relation to the amount of additional direct labor costs that is attached to the job during the new month. The budgeted production for 2013 is 2,660,000 units. This is a static level of production in black widgets (1,400,000 units) and a 20% increase in specialty widgets (1,260,000).

    Overhead application. Overhead is applied based on direct labor costs in each department. At the beginning of the current year, the Company estimated that total overhead for the forming /assembling department would be $13,500,000. Total direct labor costs were estimated to be $3,990,000. Any under/over applied overhead is assumed to be immaterial and is assigned to cost of goods sold at the end of each month. The Company currently applies overhead to production based on a single plant-wide rate. The application rates used during the past two years are as follows: 2011 - 239% and 2010 - 292%.

    In the third schedule, information is provided about the beginning work in process inventory, the jobs started during the month, and the jobs completed and moved to finished goods. There is no job in beginning finished good inventory (January 1, 2013). The direct material attached to the beginning WIP is 100% of the materials to be added. The direct labor and overhead has been added according to the percentage given. Additional labor and overhead will be added to the jobs as they are completed and moved to finished goods.

    Plant-wide overhead application rate.
    1. Calculate the predetermined overhead rate for 2013 and the amount of over/under applied overhead applicable to January. Overhead is applied based on direct labor costs. Assume that the actual overhead incurred in the month is $705,000.

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    When calculating the full cost of a product or service, a company first allocates all direct material and labor costs and direct expenses on a per-unit basis. Overhead costs are those that the business cannot directly attribute to production units, but must still include in overall costs to accurately compute a profitable selling price. As cost accountants cannot know the full cost of overheads until after they're incurred, they predetermine an absorption rate to apply to overhead costs during the accounting period. At the end of the period, they compare actual costs to absorbed costs and make an adjustment for the difference.

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    Solution Summary

    1. Calculate the predetermined overhead rate for 2013 and the amount of over/under applied overhead applicable to January. Overhead is applied based on direct labor costs. Assume that the actual overhead incurred in the month is $705,000.

    $2.19